I investigate the skill of mutual fund managers by focusing in
their holdings of a special type of stock. Kumar (2009) classifies low
price, high idiosyncratic risk and skewness stocks as ‘Lottery Stocks’,
and shows that these securities severely under-perform. I look at the
effect that these investments have on the performance of U.S. equity
mutual funds, and how they reflect on the skill of the manager. As part
of this analysis I introduce the ‘Lottery Score’, the percentage of
equity assets invested in Lottery Stocks. I find that the Lottery Stocks
that fund managers pick tend to outperform the rest of the market, and
the funds themselves persistently outperform similar funds that don’t
invest in these stocks. An investable strategy that buys Lottery Stocks
held by the funds and sells those ignored by them attains a monthly
alpha of 2%. The Lottery Score is shown to be a good predictor of fund
performance, even after controlling for a number of previously
introduced measures of skill. Since the funds’ out-performance cannot be
fully explained by their allocation to Lottery Stocks, this behavior
uncovers a more general ability for asset management.